Oh Canada! In the constant debate about whether this rally is for real or not, there is an underlying subtext. It relates to how much emphasis investors should put on Canada. In the discussion, there are many who are asking the question, why bother putting any money outside our borders?

The Canadian stock market has been the star of the show over the past decade. With the help of a strong currency, the S&P/TSX composite index has beat the S&P 500 in eight of the past 10 years (in Canadian dollar terms), and nine out of 11 when 2009 is included. And there are persuasive arguments why this will continue.

A report by Scotia Capital entitled "Why you want to own Canada" nicely summarizes them. It points out that Canada's main attributes are: 1) emerging-market exposure with lower volatility; 2) cheaper valuations relative to the MSCI World Index; 3) stronger domestic fundamentals; 4) Canadian dollar strength relative to the U.S. dollar and British pound; 5) proximity to the U.S. economy; and 6) above-average market capitalization companies in financials, materials, technology and industrials.

In a recent Globe column, David Rosenberg referred to Canada as a "low beta [less volatile]way to play the emerging markets via commodity exposure." He went so far as to say, "this period when the Canadian market outperforms its southern peers is barely halfway done."

Individual investors seem to agree. Today, they are generally tilted more toward Canada than even the most bullish strategists are recommending. I regularly see portfolios that have little or no foreign exposure. The arguments for staying at home are compelling, but investors need to understand the strategy they're pursuing when they go all-Canada all the time.

It is important to make a clear distinction between the outlook for the Canadian economy and the arguments for investing in the Canadian stock market. For one thing, the stock market has more exposure to emerging markets than the country does. In the real economy, Canada has done a poor job of penetrating the high-growth, developing markets, outside of the resource sectors. For manufacturers, China isn't a large, growing market, but rather an intense competitor. These companies aren't China plays, but rather "high beta" bets on the U.S. economy. The fact that our resource-rich country is now running a trade deficit illustrates the point.

From an investment point of view, however, manufacturing hardly registers in the market index, so the "Buy Canada" arguments are more applicable.

Of course, going all-Canada is not only a vote of confidence in our dollar and socioeconomic standing, it also means betting heavily on financial companies (31 per cent of the index), energy (28 per cent) and materials (19 per cent).

It means having little or no exposure to consumer products, technology (outside of Research In Motion) and health care, all of which are large, profitable industries with world-leading companies. It could be argued that the best "low beta" plays on emerging markets are these franchise companies that have a global reach, the likes of Procter & Gamble, Coca-Cola and General Electric.

When the current run started in 1999, our market had lagged the U.S. for eight of the previous 10 years (sound familiar?). Canadians were scrambling to increase their exposure to foreign stocks and new investment products were being created daily to help skirt the 30-per-cent foreign content limit on registered retirement savings plan accounts (remember clone funds?). The pendulum of investor sentiment has now swung completely the other way.

To my way of thinking, the long-term mix of an all-equity portfolio should be in the range of a 50/50 domestic and foreign. (I'm comfortable with the diversification that comes from holding a variety of currencies, but for investors who aren't, there are products that remove currency from the equation.) If such a portfolio is reflective of the indexes, which most are, the energy and materials weightings would be reduced to a still significant 20 and 13 per cent, respectively. Financials would drop a little to 26 per cent, while consumer, technology and health care stocks would start to play a meaningful role at 14, 8 and 5 per cent. The portfolio would still have a heavy bias toward Canada's favourite sectors.

At times like this, I can't resist dredging up my favourite quote from the late Peter Bernstein who said: "If you are comfortable with everything you own, you're not properly diversified." Commodity stocks were in the uncomfortable category in 2000, as were government bonds in 2007 and equities in general just eight months ago. Today, anything outside our borders feels uncomfortable.

Perhaps Mr. Rosenberg and crew will be right, but nine years of outperformance over the past 11 doesn't feel like halfway there to me. No matter which way it goes, however, betting on the home team still needs to be done in the context of a diversified portfolio.

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